China's premier Li Keqiang shakes hands with IMF
chief Christine Lagarde during the China Development
Forum inside the Great Hall of the People in Beijing
earlier this year

Meissen pottery from the early 18th century is highly prized
and very rare. It was the first manufacturer of porcelain in
Europe and the technology was imported, via the Dutch East
India Company, from China.

These days, technology transfer flows the other way. Since
2014 China has been on a US 'priority watch list’
for intellectual property violations. The US has been less
willing to label China as a currency manipulator, in spite of
it accumulating $3.4 trillion in reserves.

Currently the SDR is composed of the US dollar, euro,
sterling and yen. The weights are decided by the prominence of
currencies in international trade.

Those SDR weights are more or less reflected in the
currencies held by global central banks and monitored by the
IMF’s Cofer (currency composition of official
foreign exchange reserves) database.

Reserve currency status is not just a nice thing to have. It
is a powerful economic tool. Ironically, the one thing most
reserve currencies lack is large reserves. They do not need
them. They can print money and exchange them for SDRs.

Why now kowtow?

The case for the RMB is meaningful (and supported by bankers
and governments keen to have a slice of this trade). The
renminbi, according to figures from global clearing system
Swift, has displaced the US dollar and Japanese yen as the main
payment currency between China and the rest of the Asia-Pacific
region.
It is now used for almost one third of all
transactions.

This is all part of a concerted campaign to internationalise
the RMB that seems irresistible. There has a been a 68%
increase in foreign investors’ holdings of Chinese
bonds during 2014, but they still hold less than 2% of the
Chinese domestic bond market. Bank of China’s
issue of a record $3 billion, four currency-denominated bond
deal opens the market further.

Policymakers should recognise that the
artificial weakness of the RMB has been a
deliberate act of a mercantilist economic
policy

The deal was divided into 10 tranches in dollars, euros,
Singapore dollars and offshore renminbi. It was explicitly
marketed as supporting China’s plans to extend its
global influence under the 'One belt, one road’
(OBOR) policy. It includes ambitions such as building
infrastructure and trade routes between central Asia, the
Middle East and Europe over land and related projects such as
the China-Pakistan Economic Corridor, the
Bangladesh-China-India-Myanmar economic corridor and a maritime
Silk Road.

The official launch of the
Asian Infrastructure Investment Bank in the same month is
no coincidence. This is the first international development
bank launched without US backing in the post-Bretton Woods era.
The decision of the UK and other western allies to sign up to
it is shamefully self-interested.

Resistible rise of the renminbi

The IMF cannot and should not ignore the rise of the
renminbi and its role in global trade. Its inclusion in the SDR
basket seems inevitable. But with rights, special or otherwise,
come responsibilities.

Policymakers should recognise that the artificial weakness
of the RMB has been a deliberate act of a mercantilist economic
policy. It has played a role in hollowing out western
competitiveness.

There have been noises off in China about a devaluation to
counter recent dollar strength. That would be unacceptable and
is not the central case. China is more likely to continue to
loosen financial conditions to stave off the deflationary
impact of a weaker euro and yen.

The IMF is in a strong position. China’s
vaunted $3.4 trillion of reserves are not a source of strength
as they are often depicted. Even the Chinese central bank
governor accepts that the reserves "exceed our reasonable
requirements".

If China has reserve currency status, it would need less
reserves. But the old adage applies: If you owe your bank
£1,000 you have a problem, if you owe them £1
million the problem is theirs. And $3.4 trillion is a big
problem.

The Chinese central bank, to maintain its competitiveness,
buys the US dollars that its exporters hoover up by selling
RMB. This is then sterilized.

China is in a
dollar trap. It could sell its dollar holdings, though the
price action in US treasuries if the State Administration of
Foreign Exchange was a confirmed seller would be
interesting.

But even if China could sell, bringing those dollars back
onshore, the result would be massive domestic
inflation.

The IMF and other financial institutions should respect and
recognise the increasing role of China in world trade. But it
should not do so at any price.

Opening the SDR to a broader range of currencies in addition
to the RMB would make it even more relevant.

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